As the UK banks announced their 2013 full-year results, the good news was that several first half positive themes continued, with all the major UK banks back in the black. Although RBS announced their largest loss since the financial crisis, it was in the black at the operating level before impairment losses.
In 2013, underlying core profits were increasing, loan impairments were trending down and there were modest green shoots in lending volumes. Over the last five years, the banks have become safer, with £93 billion extra capital, deleveraged by £1.7 trillion, reduced their risk appetite and improved funding profiles.
Reinvention gets underway
There are still major issues facing the banks’ business models:
- Average returns on equity (RoEs) continue to trade in single digits, lower than the banks’ cost of capital. Margins remain compressed and cost cutting and headcount rationalisation continues.
- The evolving regulatory landscape is driving much more capital and less leverage. As the philosophy of ‘country-first’ regulation takes hold, universal banks face the challenge to become less global and less multi-disciplinary.
- Conduct failings and remediation of past mis-selling issues still dominate the banking agenda and costing a fortune. For 2013, it represents approximately 80 percent of the cumulative profits of the five banks. More crucially, customers still don’t feel they’re getting the products, level of service or understanding they require.
We believe that providing correct returns to shareholders and correct products to the customers plus meeting difficult regulations will require business models to change significantly. The absolute priorities are:
- Strategic choice of customers and markets: banks have to fundamentally re-evaluate which customers and places they can serve well and at a profit delivering acceptable return.
- Product innovation, done in the right way: the new banking business model has to deliver the right outcome at the right price for customers. Banks must develop products which meet rapidly changing customer needs.
- Game-changing technology: banks must significantly change operating platforms and data analytical capabilities to improve how they manage their banks, strengthen risk management and address growing cyber risks.
None of this is easy, but there are some very specific challenges right now and all stakeholders will need to step forward in response.
- Confidence to make the investment: we face a period of lower returns which constrains efforts of the banks to invest in the future. The scale of technological investment required, without immediate pay off, will put pressure on shareholder returns, especially in the short term. It will make raising capital even more challenging at a time the sector needs it the most.
- Customer products: who’s in charge – customers, boards or regulators? The balancing act of driving product innovation for customers that fits within the regulator driven view of suitable products is difficult.
- Rebuilding trust and reputation: most board members and executive management of UK banks are fairly new in role and are committed to transforming their business models. Investors, media, regulators, government, politicians and the public must give new management time to do their job plus rebuild the trust and reputation in the banks.
Is it possible to simultaneously achieve a strategy that provides the right choice of products, customers and places, delivers innovative products properly and uses game-changing technology? We believe it is, but these are not easy challenges and will require bold, innovative actions and all stakeholders have a critical role to play.